Knowledge that Transforms

IN THIS paper some of the implications of the approach to the problem of interest in a capitalist economy will be examined. A discussion directed toward interest may seem an anachronism at a time when, in discussion of the recent past, the present, and the future, the determination of the size of the national income has assumed a position of central importance, and instruments for increasing income are available which are admittedly more potent than manipulations of interest rates. But the magnitude of interest rates may have an important bearing on the extent to which private enterprise, and in particular private investment, will occupy the stage in the future. Although conditions are conceivable under which the interest burden of the national debt would not hamper private enterprise, it seems improbable that they will be realized, and I think it can be safely assumed that changes in the interest cost of the national debt will have a significant effect on the rate of private investment. Further, although Dr. Tinbergen I has found that long-term interest rates have had but a moderate effect on investment in the past and have been overshadowed in importance by profit fluctuations in the case of industry and by the shortage and abundance of houses in the case of residential building, it may well be that if a stable national income is achieved in the future, interest rates may be a factor of prime importance in determining the rate of private investment. We need not dwell for long on the question whether interest is a monetary phenomenon in the sense that to assume the absence of money is to assume away one essential determinant of interest. That question has been conclusively answered in the affirmative by the work of Professor Schumpeter and of Lord Keynes.2 Professor Schumpeter has shown that uncertainty is inherent in the process of capitalistic development; that profits are the prizes of the few who plunge successfully into the unknown; and that if the future were certain not only would the genius of the entrepreneur not be required, but existing profits would be encroached upon and finally disappear. Furthermore, in order to exploit their opportunities, entrepreneurs require command over money which enables them to obtain resources for investment either by raiding the current flow of production or by increasing it. Lord Keynes' analysis complements Professor Schumpeter's on the supply side: in order to take advantage of unforeseeable possibilities of profit or to guard against unforeseeable risks, people desire to hold liquid resources, and will surrender them only if they receive sufficient compensation in the form of interest. Since uncertainty is an ever present phenomenonif all else were assumed away, the uncertainty of human mortality 3 would remain liquidity preference is an essential ingredient of any economic situation, and therefore of any valid theory of interest. To assume the absence of money as a store of effectively, uncertainty must be assumed away, since, as Keynes has shown, people will use substitute stores of value if deprived of dollars. And if uncertainty is absent, we are confronted with Schumpeter's compelling argument that, under those conditions, there is no room for the phenomenon of interest. Since interest is a monetary phenomenon in the sense of the last paragraph, it follows that there must be some relation between the rate of interest and the quantity of money, and that, within limits, permanent effects on interest and output can be produced by changes in the quantity of money. The determination of these effects will be the subject of the following sections. Section II will follow the argument of the General Theory, but will, I hope, escape the stigma of vain repetition by suggesting some improvements of Keynes' model and by

THE method of moments has been much used to fit frequency functions whether in the Pearson or the Gram-Charlier or the Edgeworth system. In the monograph in which R. A. Fisher laid the foundation for so much of the modern development of mathematical statistics and, in particular, for his theory of the estimation of values of unknown parameters of frequency distributions of known type, he indicated that type of frequency function which could be fitted with perfect efficiency, as he termed it, by the use of the first four moments.' It is an important matter in statistical theory to follow up this suggestion of Fisher's even though one may not often fit the type of function proposed. The frequency function in question, viz.,

NI an article published in this REVIEW,2 Mr. Edward Ames has discussed a method of adjusting the income distribution of families, or other income receiving units, for changes in average income. The essence of Mr. Ames' method is the assumption that the inequalities of the income distribution will not be affected by changes in average income. More technically speaking, the Lorenz curve, which relates the cumulated percentage of families to the cumulated percentage of income received, is assumed to remain unchanged. For example, if with an average income of $I500 the lowest I7 per cent of all families receive only 312 per cent of the total national income (see Table i), then with an average of $2000 the lowest I7 per cent must still receive only 3 Y2 per cent of the income. Mr. Ames derived his method from considerations involving the Lorenz curve, but he could have put up a better theoretical discussion and obtained the same practical results without once mentioning the Lorenz curve. While Mtr. Ames' method is perfectly sound aside from the unrealistic assumptions upon which it is based -it appears to be unduly complex in theory and to require an unnecessary amount of statistical manipulation in practice. This paper presents an alternative method of adjusting an income distribution, which is fundamentally the same as that of Mr. Ames, but which is believed to be both easier to understand and much more economical to operate. If we have a distribution of families by income, and if we wish to estimate how those families will be distributed after an increase of, say, 33 per cent in the average income, we must make certain assumptions about the way in which that increase will affect families at different income levels. One possible though unrealistic assumption, which will permit an easy solution, is that all families on the average enjoy the same percentage increase, that is 33 per cent. This does not necessarily mean that the income of each family will increase exactly 33 per cent; it merely means that the high income families will not receive a greater average percentage increase than the low income families, or vice versa. For the sake of simplifying the discussion, however, we shall pretend that each family does receive an increase of exactly 33 per cent; and we shall give a more rigorous analysis in a mathematical note, following the discussion. necessary result of the assumption of a constant percentage increase for all families is that the inequalities of the income distribution, and hence the Lorenz curve, will remain unchanged. The income of every family can be doubled or halved, increased by 33 per cent or decreased by I5 per cent, without affecting the inequality of the distribution; the lower I7 per cent of families will still receive only 312 per cent of the income. But all this is incidental. The fundamental statistical problem is the adjustment of the frequency distribution so that each family will receive a 33 per cent increase. The simplest method of adjusting an income distribution is by graphic computation from a cumulative frequency curve. There are literally dozens of practical variations by which this method can be employed, but all of them are fundamentally the same. Here we shall illustrate one of t7he variations which appears to be particularly simple and straightforward. Table i presents the National Resources Committee estimate of the distribution of income in the United States for I935-36; column 2 contains the cum lative percentages of families by income level (the distribution used by Mr. Ames in his example), and column 3, the cumulative percentages of income received. These distributions are characterized by an average family income of $I502, or a national income of about 6o billion dollars divided among 39 2million families. The problem at hand is to estimate a new pair of distributions 1 The author is now serving as a Lieutenant with the United States Naval Reserve. The opinions contained in this article are the writer's own, and they are not to be construed as official or as reflecting the viewvs of the Navy Department or the naval service at large. ' Edward Ames, A Method for Estimating the Size Distribution of a Given Aggregate Income, this REVIEW, XXIV (I942), Pp. I84-89.

A NALYSIS of the capital market in respect to industrial bond and preferred stock financing during the years I933-37 is brought to completion in this article, which deals with the industrial companies that, during the period studied, floated only nonrefunding bonds and preferred stock.1 Balance sheets and income data for 36 such companies are presented. Earlier studies dealt with data for 96 industrial companies making ref undings during the period, some of which also issued nonrefunding securities; this group had assets of 9,756 million dollars in I937, while the group of 36 companies treated in the present paper had assets of 2,652 million dollars. Both classes of companies showed an expansion in assets greater than that for industrial companies as a whole, and this expansion was in part financed by the funds obtained through the publicly offered securities considered here. For the 36 companies issuing nonrefunding securities only, the resulting expansion in preferred stock and funded debt was relatively more rapid than that in assets, so that the proportion of such capitalization to total assets was raised. In the refunding group (which includes some companies making new issues), the proportion of debt to total assets declined, and an absolute shrinkage in preferred stock occurred. Both groups showed a large increase in surplus (relatively more rapid than that in total assets) and some increase in common stock. In both groups, however, common stock capitalization declined in proportion to assets. Since companies that issued only common stock were not included, only a few flotations of common stock issues appear. While nonrefunding issues were sufficiently large to affect the relative capitalization of the companies included, such issues we are dealing here with flotations offered in the open market were in comparatively small volume. The market at the time clearly did not present as advantageous conditions for nonrefunding as for refunding issues. For the latter, the rapid easing in money rates gave opportunity for savings of which financial managers could take advantage. The disturbed political and economic prospects, on the other hand, militated against new investment and expansion of assets through the assumption of new capital involving interest liabilities or preferred dividends. Nevertheless, it is clear from the statistical record that the circumstances which might be urged against the flotation of such securities were in many instances not decisive. Adequate balance sheet and income data are available for a smaller portion of the industrial companies floating only nonrefunding bonds and preferred stocks than for such companies floating refunding issues. The record for the latter is, indeed, almost complete, whereas (with the conspicuous exception of large companies issuing preferred stock) only a portion of the companies floating nonrefunding issues are represented in the corporate accounts summarized in this study. A considerable group of the smaller, less-well-known companies used in the study of rate and other characteristics of the I935-37 issues is not included here, and the sample is clearly biased toward the larger, and probably toward the better-known, companies.

Marvin Hoffenberg, Mabel S. Lewis, John H. G. Pierson, Estimates of National Output, Distributed Income, Consumer Spending, Saving, and Capital Formation, The Review of Economics and Statistics, Vol. 25, No. 2 (May, 1943), pp. 101-174

AN article in an earlier issue of this REVIEW 1 demonstrated the presence of the transport-building cycle in several important and comprehensive economic series for the United States. Mention was made of the relation of this cycle to another basic aspect of United States development, namely, urban growth. In the present note, specific consideration will be given to the existence of the transport-building cycle in the physical growth of the city of Chicago.2 Chart i is composed of a reference transportbuilding pattern for the United States,3 and of series depicting the five following types of activity representative of Chicago's physical growth: land subdividing, building, lumber receipts, manufacturing (number employed), and population growth.4 Land subdividing (representing area expansion of the city), building activity (representing structural growth), and annual population increase are three series basic to any study of urban physical development. Lumber trade throughout the nineteenth century was a dominant commercial enterprise at Chicago; and the number employed in manufacturing is a rough physical measure of the city's industrial growth.5 Examination of the movements of the five series discloses cycles that correspond to those designated as transport-building cycles in the series for the United States (top curve of Chart I). The troughs occur in I838-43, I858-62, I8748o, I896-I90I, I9I7-I9, and 1930-32. For each series and for the five series as a whole, measuring from trough to trough, the length of the cycles averages around eighteen years. With respect to timing, the series are highly synchronous; moreover, comparison of the trough periods for the Chicago series with those for the United States series reveals only minor differences. Save for population growth, which shows some tendency to lead during the nineteenth century, the Chicago series conform 1 Walter Isard, A Neglected Cycle: The TransportBuilding Cycle, this REVIEW, XXIV (I942), Pp. I49-58. 2Chicago was selected for study because (i) an abundance of data, dating from the city's infancy, was available, (2) Chicago is a primary center, (3) forces causing Chicago's growth were general and affected the development of most cities. 'This reference pattern was constructed on the basis of the series presented in the aforementioned article. The heavy solid lines represent the intervals containing the troughs of the individual series for the United States. (See Walter Isard, op. cit., p. I55, Table I.) Similarly, the horizontal dashed lines represent intervals within which the peaks of these series were reached (except that of wholesale prices during the Civil War). The peak and trough intervals are connected by dashed lines. For reasons presented in the earlier article, dating of cycles is from trough to trough, and only slight significance for purposes of timing should be attached to the peak lines of the reference pattern. Moreover, this pattern should not be construed as a composite picture of United States economic growth, nor as a cycle curve. Rather, it is a rough portrayal of transportbuilding movements isolated from other fluctuations, in which no attempt has been made to ascribe turning points and various phases to the cycle. 'Data on land subdividing, building, and population are available in H. Hoyt, One Hundred Years of Land Values in Chicago (Chicago, I933), pp. 474-83. Mr. Hoyt has described cycles in Chicago real estate which correspond closely to five of the transport-building movements. He does not include, as a cycle, movements between I899 and I9I7. Apropos of building activity, both value of buildings recorded in permits and number of building permits have been charted. The movements of these two series are in close harmony; and, for the earlier years when data on number of building permits are not available, value of new buildings, though not a measure of physical growth, may be taken as indicative of such. Lumber receipts for I833-42 are estimates from Industrial Chicago (Chicago, I89I-96), Vol. III, p. I93; data for I843-7I were taken from Chicago Herald, Illustrated History of Chicago (Chicago, I887), p. 83; from I872 on, Chicago Board of Trade, Annual Report. Data on number employed in manufacturing were pieced together from numerous sources: i850, i86o: United States Census Office, 7th Census, I850 and 8th Census, i86o; I854-56, I869-70: Chicago Herald, op. cit.; I857: Daily Democratic Press, Chicago, estimates for manufacturing activity approximately the same as for I856; i86i: Chicago Board of Trade, Annual Report, I86I; I872: E. Chamberlin, Chicago and its Suburbs (Chicago, I874), p. I29; I87398, Chicago Tribune, Annual Review Section. These data are not strictly comparable and must be interpreted with caution, especially with regard to short-run movements; in describing long-run cyclical movements, it does seem permissible to use them. Annual figures for number employed in manufacturing were not obtainable after I898. To bring into stronger relief the depression of this series in the midnineties, a dashed line has been projected for several years after I898, which roughly conforms to the manufacturing growth of Chicago during those years. 'It would have been desirable to use physical output rather than number employed, but output data were not available, and it was thought highly inadvisable to deflate value statistics by a price index constructed from very scanty material.

The data on inventions, which are used here, are based exclusively on patents issued for technological contrivance, and they do not include grants by the United States Patent Office for trade marks, labels, prints, and designs. These items are excluded because they are largely extraneous to the tangible factors of mechanical adaptation that influence processes of production. Chart i reveals clearly the tendency for inventions and production, during the entire period from I863 to I939, to move along one general course. Of particular interest, however, is the behavior of these series over shorter periods: from I863 to I894; from I895 to I9I5; and from I9I6 to I939. In the first period, following the Civil War, the yearly fluctuations were of considerable amplitude, and each series displayed an independent upward movement. During the early years of the period, the divergence between the two series was fairly wide, but a decrease in this divergence began around I878, when the

A it affects the community's propensities IV, to save and invest, so will a price-cut in any sector of the economy affect total real income. The observation is trite, but the systematic analysis of this interesting effect, in the light of recent devlopments in income theory, has not yet been undertaken. This essay, it is hoped, will provide the necessary tools for the project. The problem may be approached by considering an illuminating but probably quite unrealistic case. Suppose the producers of investment goods voluntarily reduce their prices, having been persuaded, (say) by reading the Brookings Institution study, Industrial Price Policies and Economic Progress,' that their profits ultimately will be enhanced thereby. That the producers might be disappointed the authors of the Brookings study themselves would grant the possibilityneed not for the moment concern us. What is of immediate interest is the community's gain. It is convenient and probably not remote from fact to assume that our enlightened producers execute their price reduction in a community in which the supply of money is highly elastic, and hence, in which interest rates do not change significantly under the impact of the events studied.2 Then the facts on which the impact of the price cut will depend can be discerned at once. Presumably, the reduction in prices will affect directly the demand for investment goods. That the effect will be positive, if interest rates are unchanged, is not implausible, but it suffices to observe here that unless the increase in demand is at least proportionate to the price cut, the money value of investment will be reduced. Subject to the same proviso, then, the community's investment activities will absorb less saving after the price cut than before, and saving will have to be curtailed. Apparently, unless the producers of consumption goods also are proselytized by the Brookings study, the price cut will have the paradoxical effect of reducing the community's real income. To suggest that if real income did increase, this in itself might induce an increased volume of investment is not in point. If the demand for investment were not stimulated sufficiently by the price cut alone, the increase in real income would not occur. The reduction in the price of investment goods, however, also affects at once the distribution of income. Even if the demand for investment goods did not respond at all to the price cut, could not the consequent reduction in entrepreneurial income cause the necessary reduction in saving? The answer, of course, is yesprovided that the producers of investment goods reduce their saving by the full amount of their loss. Even in this extreme although, perhaps in the shortest run, not unlikely case, however, both the community's money income and, if the price of consumption goods is unchanged, its real income are reduced. The burden is borne entirely by the adventurous, and not very abstemious, producers of investment goods. If the producers reduce their expenditures on consumption goods as well as their saving, the burden to that extent will be shifted to other members of the community. Provided the demand for investment goods responds at all to the price cut, employment, and hence the wage bill, as well as entrepreneurial income, will be altered. The question remains whether in this circumstance, at least, real income would not increase, even if the value of investment declined. The answer is neither unique nor simple. The impact of the price cut, of course, would depend on whether the change in total income as well as the change in its distribution resulted in a greater decline in the saving which the community desired to realize than in investment. Ultimately, however, real income would increase only if the 'Edwin G. Nourse and Horace B. Drury, Industrial Price Policies and Economic Progress (Brookings Institution, Washington, D. C., 1938). 2 The consideration of alternative banking policies is a task which it seems unwise to assume in this initial effort, but such a task should nrove laborious rather than difficiilt-

C. Lowell Harriss, Revenue Implications of a Progressive-Rate Tax on Expenditures: A Study of Selected Aspects of Irving Fisher's Proposal to Eliminate Savings from the Income Tax Base, The Review of Economics and Statistics, Vol. 25, No. 3 (Aug., 1943), pp. 175-191